Guest post by: Sarah Walkley is Senior Sustainability Writer, Context Europe
Environmental, social and governance (ESG) ratings have become an established feature of the investment landscape. Over 90% of investors refer to ESG ratings at least once a month, despite saying they have limited trust in the benchmarks. Companies pursue ratings because investors expect independent validation of their sustainability credentials.
Europe’s new Regulation on the Transparency and Integrity of Environmental, Social and Governance Rating Activities (the ESGR), approved in November 2024, aims to rebuild trust in the sector. Once implemented in July 2026, only authorised ratings providers will be able to operate in the EU. They will be required to publish their methodology and meet stronger governance requirements to ensure the validity and accuracy of ratings.
This will inevitably put increased pressure on ESG ratings providers, such as the Dow Jones Sustainability Index, EcoVadis and MSCI. It could also impact the companies looking to ratings to demonstrate their sustainability credentials, requiring greater detail in their annual and sustainability reports, as well as in their submissions to ratings providers.
New expectations of ratings providers
Within six months of the regulation coming into effect in July 2026, European providers will need authorisation from the European Securities and Markets Authority (ESMA) to publish ratings. For raters based outside Europe, ESMA will issue an ‘equivalence opinion’, validating that the standards in the provider’s home market reflect the EU requirements. Alternatively, the provider can partner with and secure endorsement from an EU-authorised provider to continue selling its ratings in the region.
There will also be greater scrutiny around how ratings are compiled. EU regulators want to encourage separate ratings for environmental, social and governance topics, rather than a combined assessment. Whatever the scope of the rating, providers will be expected to review and publish their methodology at least annually, including:
- The time horizon covered and whether the analysis is forward or backward looking.
- The nature of the impacts and risks reviewed. For example, is the provider assessing the financial impact of a sustainability topic on the company (financial materiality), the company’s impact on people or planet (impact materiality), or a combination of both (double materiality).
- The topics covered within the individual environmental, social and governance aspects of the assessment.
- The industry classification used.
- The source of the data used for the analysis, e.g. individual company questionnaires, company sustainability reports, or other information in the public domain.
- The weighting given to the individual E, S and G aspects in any combined ESG rating.
- A summary of the limitations of the analysis.
The need for reform
Currently, ratings can vary substantially. A company could receive AAA+ in one assessment, but barely achieve a score of 30 out of 100 in another. A review by the International Organization of Securities Commissions (IOSCO) pointed the finger at a lack of transparency about methodology and the absence of any commonly agreed definitions for ESG topics. The selection of topics covered within a rating may also be partly to blame.
Depending on the company and the sector, some topics may be critically important — others less relevant. In their annual or sustainability report, companies understandably focus on the material issues and often provide no or less detail on lower priority or emerging topics. This results in gaps in information that may be filled in a variety of ways depending on the ratings provider. Some use estimates to complete the picture — for example using the average score for an industry or sector. Other providers expect issues to be covered in public reporting regardless of their importance to the business and equate a lack of data with a lack of transparency. A company’s low score could be the result of being judged on issues that are not material rather than a lack of action. The reason for a particular score will become clearer when there is greater openness from ratings providers on methodology.
ESG ratings are widely considered an assessment of a company’s sustainability strategy and performance. In fact, they are more of an indication of a company’s exposure to material risks and how well those risks are being managed. Again, greater transparency in relation to the nature of impacts and risks reviewed will make this clearer.
Coverage is uneven. Some providers only rate the companies that apply to them for assessment. Others only track certain sectors, but aim to cover all organisations within that industry. This results in some industries and geographies receiving less attention than others. It also enables unscrupulous companies to cherry pick ratings providers based on the favourability of the rating. With greater regulation, the EU hopes to bring increased standardisation.
ESGR Implications for companies
The ESGR is part of the European Green Deal, alongside the EU Taxonomy, the Sustainable Finance Disclosure Regulation and the Corporate Sustainability Reporting Directive (CSRD).
Regulators had originally hoped that ESG ratings providers would be able to base their assessment on the detailed reporting required under CSRD. This would reduce the need for ESG ratings providers to scrape data from websites or send out individual content questionnaires and shift the focus from content collection to interpreting publicly-available information. The result would be greater consistency and comparability of ratings.
The EU Omnibus has stripped reporting requirements under CSRD back substantially. Many ratings providers evaluate more information than the minimum requirement under the updated regulation. Companies looking to maintain and improve strong ratings will continue to face the burden of compiling and submitting voluntary disclosures.
They may also see their ratings decline. Partly in anticipation of having to provide greater detail on their methodology, several ESG ratings providers have begun to update their approach. Sustainalytics now bases its assessment public disclosures only. It estimated that three-quarters of companies would experience a two-point drop in score, though private companies saw scores drop by over four points due to a much greater reliance on dedicated submissions historically.
Increased transparency around methodology should bring greater clarity on how companies are being judged. There will also be greater pressure on companies to be clear about how and why an issue is important for the business. Without that, ratings providers could struggle to assess whether an issue is a financial risk for the company, one where the organisation has an external impact, or both — ultimately affecting the score.
Distinct ratings for environmental, social and governance issues will also help, particularly in some sectors. For example, a service company may have a significant social impact, but a relatively low carbon footprint. This would mean that they report in detail on social issues, but provide less granularity on what they are doing to reduce emissions. This could translate to an average score on a general rating, but a good score on a dedicated social assessment.
How should companies prepare for ESGR?
Given the significant variability in ESG ratings between providers, there have been very few consequences for companies from a low rating — there are so many methodological reasons for a low score that a poor rating does not automatically equate to poor performance. That could begin to change as rules around the ratings market tighten, meaning a company’s reputation suffers or it becomes tougher to access investment. So how should companies prepare?
- Short-term changes. Companies should review which ratings they participate in, focusing on those that are most trusted by investors and other stakeholders. For other ratings, they should also plan how to communicate any changes to their score that result from methodological updates. They want to avoid stakeholders misinterpreting a downgraded score as a sign of lack of progress or a decision to roll back on the company sustainability strategy.
- Materiality matters. A double materiality assessment is a requirement of the CSRD, guiding what topics a company reports on. Ratings providers are likely to increase their scrutiny of material issues, reinforcing the need for a robust initial assessment and to be explicit about how and why sustainability topics are important to the business.
- Reporting and transparency. In future, an ESG rating is more likely to be based on a company’s sustainability report than a dedicated questionnaire. While the company may have an opportunity to fill in gaps or respond to specific queries from ratings providers, it will be critical to be as transparent as possible in the annual report.
About the author:
Sarah Walkley is Senior Sustainability Writer at sustainability strategy and communications agency Context Europe.
She has over 25 years of professional writing and editing experience across multiple formats and has written for a broad range of audiences from business and government to academics and consumers. She is a former member of the Executive Leadership team at Autovista Group where she headed up development of the group’s sustainability strategy.
Sarah is an expert on reporting frameworks and requirements, including CSRD. You can read her recent guide to sustainability reporting, covering CSRD and more, here.
She holds a Master’s with Distinction in Sustainability Leadership from the Cambridge Institute of Sustainability Leadership, part of the University of Cambridge.
